Investment time horizons cut short

All three AFI indices have seen dramatic falls since the onset of the financial crisis resulting in widespread sell-offs and shorter horizons, which is raising concern among the panellists.

As macroeconomic news seems to move from bad to worse, investors’ confidence in the value of their investments has been tested, resulting in widespread sell-offs. The shortening of investment horizons that this implies is a cause for concern for Adviser Fund Index (AFI) panellists.

The three benchmark AFI indices have seen dramatic falls over the past year, almost wiping out gains made since inception. The Aggressive index is down 30.03% over the
past 12 months, with the Balanced index down 24.82% and Cautious falling 20.44%, according to Financial Express.

The drastic downturn in the fortunes of the three indices illustrates that even cautious-minded investors were unable to avoid significant losses within their portfolios, although they may have dodged the worst hits.

Since the start of the data in October 2004, all three indices followed a relatively smooth upwards trajectory. The onset of the financial crisis in 2007 reversed this, however, and from a peak return of 68.04% in the Aggressive index on October 29 of 2004 – exactly three years after launch – it declined sharply to a return of 5.63% from inception.

A similar story can be seen with the Balanced and Cautious portfolios, which returned 4.9% and 1.66% respectively, since the indices were launched.

The widespread equity sell-off has helped drive down global equity markets. The FTSE 100 fell last week to its lowest level since 2003, with fears that it could fall further.

The problem with this strategy is that it crystalises losses incurred during a cyclical downturn that, historically speaking, should give way to a recovery in the medium term.

“In theory you should extend your time horizons [in current market conditions], but in practice the opposite tends to happen,” says Mick Gilligan, the director of fund research at Killik. “In a way it makes sense as they’ve seen their capital eroded and that has had implications for their psychology.”

James Davies, an investment research manager at Chartwell and fellow AFI panellist, says he noticed a sharp swing in investor time horizons, even before the crisis really began to take hold.

“Investor time horizons have been shortened dramatically over the past few years,” says Davies. “This has been due to governments, the media and, of course, our own industry. If you look at the way people piled into property something was obviously rotten in the system.”

Last year firms were forced to defer redemptions and even halt trading on property funds. Groups including New Star, Norwich Union and Aviva Investors were forced to suspend redemption payments following a collapse in sentiment towards the sector. As Fund Strategy reported on December 10, 2007, AFI panellists were already cautious on commercial property, which they felt would suffer during an economic slowdown, a conjecture that has proven to be a wise one.

With a seemingly endless stream of negative news across most sectors, however, it is increasingly difficult to lure investors out of cash, despite some markets trading at historically low levels. While in the short term this could prove a wise strategy as it avoids any further falls, staying out of equities could mean that they risk missing a recovery.

“You can’t persuade someone to re-invest when they’ve suffered a financial bereavement,” says Davies. “You have to ensure that you’ve positioned them well to start with and are not switching around their portfolios all the time, as that’s what financial advisers ought to be doing.”

In volatile markets it has proved extremely difficult to find managers who were able to protect capital, let alone
provide capital growth. In many ways this is because markets appear to be reacting more strongly to macroeconomic themes, rather than company fundamentals. This renders bottom-up stockpicking a less significant factor to a manager’s success.

“I think bottom-up stockpicking counts for very little in these markets in a six-to-12 month view, although it will be important in a three-to-five year perspective,” says Gilligan. “Most people are looking for capital growth and if you cannot stomach the losses you probably shouldn’t be in 99% of equity funds at the moment.”

Gilligan says the crisis has thrown the spotlight onto star managers such as Invesco’s Neil Woodford who have managed to protect investors’ capital more successfully than their competitors.

Davies agrees, and says the trauma of the crisis may help root out weaker managers and advertise those with a robust investment process.

“This sort of calamity allows us to go back to the beginning making sensible investments with long-term investment horizons,” he says. “I wouldn’t be surprised if the total number of funds in the AFI shrinks as successful managers shine through.”

The crisis has already exposed managers who were taking on risk during the good times, but it has also thrown up portfolios which have managed to weather one of the most challenging investment environments for a generation.

Those funds that can survive are likely to pick up sufficient assets from their competitors to take full advantage when stockmarkets finally turn.

The Adviser Fund Index series – a summary

The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs.

Performance of AFI indices